A low ratio, on the other hand, suggests poor sales, sluggish market demand, or an inventory surplus. Calculating inventory turnover ratio helps you make business decisions about pricing, purchasing, marketing, and more. Before calculating the inventory turnover ratio, we need to compute the average stock and cost of sales. A company with a low inventory turnover ratio may be holding obsolete or slow-moving inventory that is difficult to sell or has low demand.
A low inventory turnover ratio might suggest overstocking, slow-moving inventory, or inadequate sales. A “bad” ratio varies by industry but generally indicates inefficiencies, tying up capital, and possibly leading to increased carrying costs or obsolescence. Reassessing your position within the industry and adapting accordingly can impact inventory turnover. Understanding market demand, trends, and consumer behavior helps in aligning inventory levels with what customers want. For instance, focusing on products with higher demand or differentiating your offerings to stand out within the market can positively impact turnover.
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Average inventory in denominator part of the formula is equal to opening balance of inventory plus closing balance of inventory divided by two. The use of average inventory rather than just the year-end inventory balance helps minimize the impact of seasonal variations in turnover. A good inventory turnover ratio is typically between 5 and 10 for most industries.
The best way to determine a “good” inventory turnover ratio for your business is to start tracking it. Once you have a baseline number to work with, you can adapt your inventory control. You can cope with a low inventory turnover ratio more easily if your business sells items that don’t spoil. In general, a result of between 5 and 10 after completing the inventory turnover ratio formula is considered a “good” inventory turnover ratio for most businesses. You can also use the inventory turnover ratio for business forecasting, to identify market trends, and more.
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